Introduction The Decentralized Finance (DeFi) Revolution is taking over traditional finance (TradFi) and centralized exchanges (CEX), with billions in...
Over the past year, there have been many entrants in the stablecoin space. A year ago, the different types of stablecoins were explaining why their model was best. As with anything, there are tradeoffs with each model, but after the stablecoin war has developed a clear winner is emerging. Fiat-backed stablecoins have shown resilience by maintaining their peg despite volatility in the cryptocurrency market. By market share, fiat-backed stablecoins are the clear leader.
Above shows the stablecoin market share, clearly dominated by fiat-backed stablecoins even when Tether is not included. New entrants, including Stably, have quickly gained market share and expanded the total market cap of stablecoins.
The risk of cryptocurrency-collateralized and uncollateralized stablecoins have been discussed ad nauseam. Uncollateralized stablecoins (also known as algorithmic stablecoins) are yet to reach production and gain traction. The most notable uncollateralized stablecoin project, Basis, shutdown in late 2018 after seeing too much regulatory risk. This poses a problem for other algorithmic stablecoins looking to enter the market.
“As for purely algorithmic stablecoins; to be frank, this is a contender for worst idea in the whole space (which is saying something); Basis returning its investors’ funds was one of the saner moments in crypto history.” — Daniel Goldman
During the same period, cryptocurrency-collateralized stablecoins have experienced their own issues. BitUSD, part of the BitShares ecosystem, experienced a peg break in late 2018 and has never fully recovered. In November 2018 the dollar peg broke and price dropped to 70 cents. A resilient stablecoin would quickly recover, BitUSD did not. The price has stayed below $1 and only reached a steady level of 90 cents in the past few weeks. The chart below shows BitUSD price over time.
DAI is the most popular cryptocurrency backed stablecoin but has recently experienced its own issues. This article mentions MakerDAO’s founder expressing concern over the lack of demand for DAI. He even goes as far as saying the peg is “almost at a breaking point”.
The stability fee is another significant issue for DAI. This fee is charged when CDP owners pay down their debt position. The stability fee is currently at 1.5% APR, compounded continuously, but that is expected to be raised to 3.5% in the near future. This places DAI at a disadvantage as fiat-backed stablecoins do not typically impose fees.
Given the problems facing uncollateralized and cryptocurrency-collateralized stablecoins, it’s no surprise fiat-backed stablecoins are leading the way for the stablecoin market. The stability offered by fiat-backed stablecoins is unmatched, as is the liquidity provided for traders.
“So fiat-backed stablecoins introduce a clear locus of trust on top of protocols designed to minimize it (I think this is uncontroversial). What I think many in the crypto space miss is that for these systems to be secure, they actually need more boring, traditional trust mechanisms (public audits, regulatory compliance, etc.) than traditional institutions do.” — Daniel Goldman
Stablecoins have created a new market targeting remittance, international-friendly payment systems, and an on ramp for traditional finance to move into its inevitable digitized future. Founder of the Evolvement Podcast and influential cryptocurrency trader Michael Nye is quoted saying,
“Stablecoins have the potential to revolutionize our current banking system, saving time and money on transfers between individuals. It may not be the decentralized solution the Bitcoin community desires, but it has the potential make our current systems simpler.”
Recognizing the effect this will have on the world’s economic future, it’s important to understand the differences between each type of stablecoin. Cryptocurrency-collateralized, fiat-backed, algorithm-backed, asset-backed tokens all have their purpose, but it appears fiat-backed is earning its title for the most reliable for stability, liquidity, and usage.
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